In Economics, Politics

Do We Even Know What They Are Scared Of?

Posted by: on Aug 9, 2011 | No Comments

Or, for that matter, do they?  ”They” would be investors, who, according to the media, are still running scared from the implications of the unprecedented S&P downgrade and overall economic weakness. At least it’s half right.

At the same time that media has reported investor panic relating to the downgrade, it has also reported that investors are flocking to treasuries in the U.S., Great Britain, and Germany. A quick look at U.S. Treasury yields for the month of August supports this idea:

DATE 5 YR 7 YR 10 YR 20 YR 30 YR
08/01/11 -0.75 -0.21 0.33 1.09 1.34
08/02/11 -0.76 -0.25 0.29 1.03 1.26
08/03/11 -0.62 -0.10 0.36 1.03 1.29
08/04/11 -0.67 -0.19 0.24 0.88 1.15
08/05/11 -0.59 -0.12 0.32 0.99 1.25
08/08/11 -0.63 -0.22 0.20 0.88 1.14
Monday Aug 8, 2011, 4:13 PM
While yields on 5-Year Securities is up ever so slightly, all other U.S securities have been falling every day since August began.  To me this suggests a major disconnect between S&P and the market, as well as between the media & the market.  S&P concentrated on the debt level of the U.S., and the poisonous politics that surrounded the debt deal and concluded (using their crystal ball, I suppose) that politics in the U.S. would continue being ridiculous.  And while that may turn out to be right, the fact of the matter is that the S&P seems to have fundamentally missed what exactly investors were scared of.
Rather that being afraid of the downgrade, investors seem more likely to be afraid of the implications of the debt deal, and S&P and Moody’s calls for even greater austerity measures.  Paul Krugman explains it like this:

It’s not the whole story, but something like this threatens to develop:

1. US debt is downgraded, sparking demands for more ill-advised fiscal austerity

2. Fears that this austerity will depress the economy send stocks down

3. Politicians and pundits declare that worries about US solvency are the culprit, even though interest rates have actually plunged

4. This leads to calls for even more ill-advised austerity, which sends us back to #2

Behold the power of a stupid narrative, which seems impervious to evidence.

So rather than fearing the downgrade itself, investors have noticed that the debt deal sucked for big reason that I went over in a recent entry.  They’ve noticed that the economic fundamentals, like GDP growth and inflation, all happen to be horrendous, and that the debt deal takes some major tools off the table that historically have been used to tackle these selfsame problems.  That’s not the story S&P sees though, and it’s not the story the media is reporting on.  Instead, we get drivel about how the downgrade has rattled markets, while I think the weak economic fundamentals that investors seem to have noticed open the possibility of a double dip recession, coupled with continuing instability in the Eurozone.  If the downgrade, which had been widely expected, had really rattled markets, we wouldn’t be seeing that drop in U.S. security yields that are, in fact, real.  Investors still have a degree of rationality to them, even if S&P and the media don’t.

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